Intra-Regional Foreign Direct Investment- The South Asian Perspective

Jahangir Alam Associate Professor

Department of Finance and Banking University of Chittagong

Bangladesh. Email: jahangira@hotmail.com / jahanalam@yahoo.com

Phone: ++88-031-684543

&

A.F.M. Aowrangazab Associate Professor

Department of Management University of Chittagong

Bangladesh. Email: jahangira@hotmail.com / jahanalam@yahoo.com

Phone: ++88- 031-657496

2

INTRA-REGIONAL FOREIGN DIRECT INVESTMENT – THE SOUTH ASIAN PERSPECTIVES

Abstract

Global economic events of the past decade or so, particularly those driven by

technological advances, regional integration and the realignment of economic systems

and policies, have altered fundamentally the perception of the governments of the host

countries of how Foreign Direct Investment (FDI) can contribute towards their economic

and social goals (Dunning, 1994). This is, indeed, a subject matter of developing

countries like Bangladesh for accumulating capital to fuel the gap between saving and

investment with an ultimate goal of economic development by creating employment, by

transferring technology, and to achieve sustained economic growth. Moreover, different

countries have also been taking different legal and institutional measures to cope with the

globalizing economy and to reform the national economic policies to accommodate the

pressures from different supranational organizations like the IMF, the World Bank, WTO,

IFC, etc.

This article attempts to examine some critical points of FDI within South Asian countries.

These points include present scenario of FDI in the region, the existing and potential

benefits from intra-regional flows of FDI, the attitudes of nationals towards FDI, the

present and potential threats to FDI and some remedial suggestions in achieving the

targets set by the respective nation. The article also tries to find out the economic

interdependences among the countries of South Asian Association for Regional

Cooperation (SAARC) in terms of FDI.

It has been found that South Asian countries’ performance of attracting FDI is not up to

the mark. The reasons of such situation have been analyzed and critical points and factors

affecting low performance in attracting the same have also been identified. It has been

suggested that these countries can use FDI as an important tool of reducing or eliminating

poverty that can also act in building an effective SAARC by reducing regional

imbalances in trade and FDI.

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Intra-Regional Foreign Direct Investment- The South Asian Perspective 1. Introduction

Foreign Direct Investment (FDI) is the acquisitions of foreign assets for the purpose of

control them. FDI occurs when a firm invests directly in facilitating to produce and / or

market a product in a foreign country. The U.S. Government Statisticians define FDI as

“Ownership or control of 10 percent or more of an enterprise voting securities.... or the

equivalent interests in an unincorporated U.S. business’ (Quijana, 1990). FDI is net

inflows of investment to acquire a lasting management interest (10 percent or more of

stock) in an enterprise operating in an economy other than that of the investor. It is the

sum of equity capital, investment of earnings, other long term capital, and short-term

capital as shown in the balance of payments. Gross capital formation is the sum of gross

fixed capital formation, changes in inventories, and acquisitions less disposals of

valuables (World Development Indicators 2003). FDI may take many forms such as;

purchase of existing assets in a foreign country, new investment in property, plant and

equipment, and participation in Joint Venture with a local partner.

Global economic events of the past decade or so, particularly those driven by

technological advances, regional integration and the realignment of economic systems

and policies, have altered fundamentally the perception of the governments of the host

countries of how Foreign Direct Investment (FDI) can contribute towards their economic

and social goals (Dunning, 1994). This is indeed, a subject matter of developing countries

like Bangladesh for accumulation capital to fuel the gap between saving and investment

with an ultimate goal of economic development by creating employment, by transferring

technology, and to achieve sustained economic growth. Moreover, different countries

have also been taking different legal and institutional measures to cope with the

globalizing economy and to reform the national economic policies to accommodate the

pressures from different supranational; organizations like IMF, the World bank, WTO,

IFC, etc.

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South Asia consists of seven countries namely, India, Bangladesh, Sri Lanka, Nepal,

Bhutan and the Maldives. The dollar-a-day poverty incidence in South Asia is currently

around 37 percent. Over the years, income poverty has shown considerable decline in the

region. However, the rate of decline in South Asia is much lower than that of East Asia

and the Pacific. Also, South Asia remains as the region with the largest number of people

living in poverty. Though it accounts for 20 percent of the global population, it is homes

for 40 percent of the world’s poor. In absolute numbers, it accounts to 400 million people,

more than all the poor people of sub-Saharan Africa, the Arab states, Latin America and

the Caribbean put together. Similarly, in terms of poverty indicators, such as child

mortality, maternal mortality, youth literacy, primary school enrolment, etc., the general

trend is one of improvement, but these are still at very undesirable levels. Despite

measurement problems, inequality in terms of both Gini Coefficient and ratio of

income/consumption share of the richest 20 percent to the poorest 20 percent appears to

be on the increase in the region (Sobhan, 2004). The economic indicators of the countries

under SAARC are shown in Appendix-1.

This paper attempts to examine some critical points of FDI within South Asian countries.

These points includes present scenario of FDI in the region, the existing and potential

benefits from intra-regional flows of FDI, the attitudes of national towards FDI, the

present and potential threats to FDI and some remedial suggestions in achieving the

targets set by the respective nation. The article also tries to find out the economic

interdependence among the countries of South Asian Association for regional

Cooperation (SAARC) in terms of FDI.

It has been found that South Asian countries’ performance of attracting FDI is not up to

the mark. The reasons for such situations have been analyzed and critical points and

factors affecting low performance in attracting the sale have also been identified. It has

been suggested that these countries can use FDI as an important tool of reducing for

eliminating poverty that can also act in building an effective SAARC by reducing

regional imbalances in trade and FDI.

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2. Review of Literature1

One of the sensitive areas in international economics is FDI as it is now defined not only

merely a simple transfer of money but a mixture of financial and intangible assets like

technologies, managerial capabilities, and marketing skills and other assets. The present

form of FDI that gained momentum after World War-II mainly originated in the United

States, when it was regarded as a means to increase their political hegemony on a world

level (Bulcke, 1987). Dunning (1958) published a comprehensive book on the

consequences on inbound FDI for host countries where he took United Kingdom as a

subject of study. Later on, there have been more publications on the substantive studies

for Canada (Safarian, 1966), Australia (Brash, 1966), Norway (Stonchill, 1965), New

Zealand (Deane, 1970), the Netherlands (Stubenitsky, 1970), Kenya (Longdon, 1981),

Singapore (Mirza, 1986), the United States (Graham and Krugman, 1989), India (Kumar,

1990), Mexico (Peres-Nunez, 1990), and Central and Eastern Europe (Aristien, Rojec and

Svetlicic, 1993), which carry weights in the field of FDI. It has been observed these days

that hundreds of books, theses and Government reports, and thousands of papers in

academic and professional journals have been written on FDI (Dunning, 1994). There are

different dimensions covered by different books and articles. For example, after thirty-six

years of publication by Dunning (1958), his emphasis has been shifted to cost-benefits of

FDI in 1994. Bulcke (1987) has been found interested in evaluating policy framework in

the context of developing countries. Michalet (1994) shows that Transnational

Corporations (TNCs2) are the main driving forces of new international economic system.

The impacts of FDI to economic growth have been debated quite extensively in the

literature. The ‘traditional’ argument is that an inflow of FDI improves economic growth

by increasing the capital stock, whereas recent literature points to the role of FDI as a

channel of international technology transfer (Lensink and Morrissey, 2001). There is

growing evidence that FDI enhances technological change through technological

diffusion, for example, because transnational / multinational firms are concentrated in

1 Extracted from Alam, Jahangir (2005). 2 Although there are subtle differences in TNCs and MNEs, we shall use these words interchangeably to mean the same type of organizations.

6

industries with a high ratio of R&D relative to sales and a large share of technical and

professional workers (Markusen, 1995). TNCs are probably among the most

technologically advanced firms in the world. Moreover, FDI not only contributes to

imports of more efficient foreign technologies, but also generate technological spillovers

for local firms. Kinoshita (1998) and Sjoholm (1999), on the other hand, argue that FDI

works as a tool of knowledge spillovers that may take place via imitation, competition,

linkages and / or training. A comprehensive study by Bosworth and Collins (1999)

provides evidence on the effect of capital inflows on domestic investment for 58

developing countries during 1978-95. The sample covers nearly all of Latin America and

Asia, as well as many countries in Africa. The authors distinguish among three types of

inflows: FDI, portfolio investment, and other financial flows (primarily bank loans). They

find that an increase of a dollar in capital inflows is associated with an increase in

domestic investment of about 50 cents.

A comprehensive study has been done by Agrawal (2000) to evaluate the economic

impact of FDI in South Asia where he took Bangladesh as one of the sample-countries of

his study. He found that the impact of FDI inflows on GDP growth rate was negative

prior to 1980, mildly positive for early eighties and strongly positive over the late eighties

and early nineties, supporting the view that FDI is more likely to be beneficial in more

open economies. He also found that since 1980, FDI inflows contributed more to GDP

growth in South Asia than did an equal amount of foreign borrowing. This suggests that

FDI is preferable to foreign borrowing.

3. Scenario of foreign Direct Investment in South Asia

Apart from Sri Lanka, countries of South Asia only began to offer the incentives needed

to attract foreign direct investment (FDI) in the 1990s. India relaxed restriction on FDI

and portfolio investment in 1993, and a substantial inflow commenced in 1994 reaching

an estimated $3.5 billion in 1997. Early inflows were dominated by short-term capital

from non-resident Indians (NRIs) and from foreign institutional investors (FIIs). FDI only

caught up with FII flows in 1996.

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Net foreign investment in Pakistan was negligible in 1980s. It has attracted limited FDI in

the 1990s, i.e. a range from $200 million in 1991 to $400 million in 1995, averaging

around $310 million annually. There was a sharp increase in 1996 associated with a

single investment in a power plant, but it fell in $684 million in 1997 (SBP 1997). Inflow

of portfolio in vestment in the 1990s was initially low at $84 million in 1992. It was rose

around $270 million in 1992 and 1993 and more steeply to $1.3 billion in 1995 associated

with the privatization of the Pakistan Telecommunication Corporation but fell to $378

million in 1997.

Bangladesh has recently been attracting small and variable volumes of FDI in the 1990s

ranging from $41.5 million in 1992 to $407.5 million in 1994, falling to $104 million in

1995. The variations were due to investments in a large fertilizer plant. FDI was

negligible in 1996 and 1997 owing to political disturbance in 1996.

In Nepal, new incentives have been succeeded in attracting small inflows in recent years.

From 1992 to 1995. authorized FDI in joint ventures and collaborations totaled $784

million of which actuals were $624 million.

In Sri Lanka, there was a surge of FDI from 1989, accompanied by a substantial but

variable inflow of portfolio investment in the 1990s. The second wave of reforms set the

stage of the surge, aided by new internationalization moves by manufacturers in Japan

and the newly industrialized economies (NIEs) in East Asia (especially Korea) in

response to their massive exchange rate appreciation and domestic wage increase. Annual

inflows increased from around $50 million in 1990 to $187 million in 1993. The inflow

fell away following the change in government in 1994. The total number of projects

attracted by the Board of Investment (BOI) declined from 327 in 1993 to 270 in 1994,

and only 139 projects in 1995. The foreign component of total investment in contracted

projects has declined dramatically over 77 percent during 1989-92 to less than 45 percent

during 1993-95. A comparison of the Sri Lankan experience with that of other countries

in Asia, such as Malaysia, Indonesia, Vietnam, and even India, suggests that the

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significant decliner in FDI in Sri Lanka was predominantly an isolated ‘home-made’

phenomenon and not part of a regional pattern (Athukorala and Shand 1997)

Most of the South Asian countries have undertaken far-reaching economic reforms: they

have adopted industrial policies that encourage foreign direct investment (FDI) resulting

in an increase in FDI flows. However, the amount of inflows attracted by the regions

remains relative to East Asia and South East Asia quite insignificant. In 1998, it was

US$ 3.43 billion, a mere 0.5 percent of global flows. In contrast, China received more

than 10 percent of global inflows. By 2002 although total FDI flows to South Asia had

increased to Us$ 4.58 billion, this was still well below 1 percent of global FDI inflows.

FDI to the region is predominantly from outside the region. The sectors that have

attracted most foreign investment vary between countries. In the case of Bangladesh, and

Sri Lanka, the textile and garment sectors account for 28 percent and 16 percent

respectively of FDI, whereas 56 percent of FDI has gone into infrastructure projects in

India. In the case of Pakistan, 40 percent of all FDI has gone into the power sector. While

FDI from outside the regions has been far greater than intra-regional investments, there

are signs that intra-regional investments are increasing. The major inward FDI flows are

from Indian firms, which have started to expand FDI both within South Asia and beyond.

Firms from other South Asian countries are also increasingly undertaking FDI within the

region and investing in a wide range of sectors and activities.

There are two SAARC countries, Nepal and Bhutan, where FDI from India is the

predominant source of FDI. On the other hand, none of the SAARC countries are

significant investors in Pakistan though there is a very limited FDI flow from other

countries in the region. India is the largest investors among the SAARC countries in the

Sri Lanka, while Pakistan and Maldives are respectively second and third to India as

investors. In the case of Bangladesh, firms from India, Pakistan and Sri Lanka have in

recent years invested US$ 418 million in 133 ventures covering a wide range of sectors.

In spite of India’s huge internal market, investment from other SAARC countries have

been quite insignificant, both in relative and absolute terms, accounting for less than one

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per percent of total foreign investment in India. Bangladesh is the largest investors in

India from the region, followed by Sri Lanka, Nepal and Maldives.

The Lafarge Surma Cement in Bangladesh is the single largest cross border investment in

the region involving a major multinational firm, Lafarge, a French multinational, is one

of the largest cement manufacturers in the world. The plant is expected to go into

production very shortly. The raw materials, mainly limestone and shale, for this 210

million dollar joint venture cement plant in the district of Sylhet, located Northeastern

Bangladesh close to the Indian border will be supplied from a quarry in the bordering

state of Megalaya. The plant, one of the largest in the region, and the quarry are

connected by a 17 kilometer (11 mile) cross-border conveyor belt to transport the lime

stone. The plant will have an initial capacity of 1.2 million tons of cement per annum

although this capacity is expected to be doubled in due course.

Another example of a successful joint venture is the rubber sector in Sri Lanka. The

vertical joint venture was initially between an Indian motor vehicles company,

Associated Motorways Private Ltd. and the Sri Lankan subsidiary of CET for the

manufacture of tyres. Sri Lanka, which did not have a developed rubber-based industry,

gained greater access to the protected and growing Indian market, while India obtained

easy access to the supply of good quality natural rubber. At the end of the day both

countries benefited through this joint ventures.

This is evident from the above-mentioned facts that the intra-regional flows of FDI

among the member states of SAARC are negligible.

4. Potential Benefits of Intra-Regional Flows of FDI

Various statistics show that there exists an acute poverty in the Member States of the

SAARC (different poverty indicators have been provided in Appendix-2). There are

different ways and means of eradicating poverty and almost all the Member States of the

SAARC keep poverty alleviation as the top policy agenda in formulating their fiscal

measures in the short run and development plans in the long run. Researchers have

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identified various causes behind the poverty of the region. Low level of economic

dynamism is considered as one of the key factors of economic backwardness of the States

of the SAARC. The South Asian Center for Policy Studies (SACEPS) 3 and Asian

Development Bank4 have identified two causes of economic backwardness. These are

lack of investment capital accumulation and regional cooperation. Investment capital can

be accumulated through FDI that can be ensured by effective regional cooperation.

Unlike East and South East Asia where regional cooperation initiatives have contributed

significantly to the economic growth of the countries in these regions through an increase

in inter-regional trade and investment, regional cooperation in South Asia remains weak.

An opportunity for accelerated growth and further energizing the economies of South

Asia does exist by increasing investment through regional cooperation. Therefore,

enhancing investment cooperation and facilitating investment among countries in the

region will be crucial for the development of the economies in the region (Sobhan, 2004).

There are different sectors for investment within the region. Three sectors have already

been identified (Sobhan, 2004) that can be treated as some of the potential sectors of

intra-regional investment. A short description of each of these three sectors is given

below;

1. The Energy Sector: Bangladesh, Bhutan, India and Nepal can develop join

cooperation for investment for the utilization of thermal and hydropower

efficiently. In this regard it can be stated that Indian reserve of coal and

Bangladesh reserve of coal and gas can be utilized effectively whereas locations

of Nepal and Bhutan can be chosen for their large untapped hydro-power potential.

Indian giant Tata group has already understood this potential and has started to

negotiate a two billion dollars investment in Bangladesh.

2. Transport and Communication: This sector is also considered an important and

profit earning sector of investment in this region. Because transport and

communication systems of all the Member States are not well developed that

3 SACEPS Task Force Report on Common Investment Strategy for South Asia (2003). 4 Asian Development Bank (1996). Background Paper on Regional Cooperation in South Asia.

11

hampers the flow of goods and services within the region. Investors may take this

sector to invest for the long-term generation of income.

3. Information Technology: information technology (IT) plays an important role

by increasing connectivity, communication and transparency in the business

process. In this case India can take a lead to develop this sector in the region so

that India can also gain by utilizing IT specialists of different Member States.

However, we are going to identify some more sectors for investment in the region that are

yet to be identified:

1. Agriculture: The economies of all the countries in the region are highly

dependent on agriculture. South Asia, one of the major growers of agricultural

commodity, and a major growth region in the present world, has bright prospect

in exporting agricultural products. The trade prospect in south Asia is to be

influenced by the region’s attempts in stabilization, and reforming the economic

policies as well as by changes in the external environment and internal policy

adjustments to those changes (Hossain, 1999). Although agriculture is one of the

most important sectors contributing to the GDPs of the respective countries in the

region, there has been lagging behind in the industries for the food processing

plants that hampers the preservation of agricultural products. This affects the

farmers in getting reasonable prices of their products and countries are also

deprived in export earnings of those products. Intra-regional investment can be

encouraged in agricultural product processing, preservation, packaging and

transport industries.

2. Tourism: As an industry, its position is second in the world only by petroleum

industry. The main reasons of growth of tourism industry in the world are

growing prosperity especially in the areas or regions from where the bulk of

international tourists originate, continuous reduction in the work time leading to

more leisure time, lessening of travel costs and time due to rapid development in a

aviation technology, increasing flow of information about the place, and men /

women’s natural desire to see new places and experience himself / herself what

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they have been told and to escape from monotonous and hectic life of industrial

societies. Development of tourism industry in SAARC is not up to the mark. It

was concluded by Jyoti (1996) in the first seminar that inspite of having one-fifth

share of the humanity and having all the attributes for becoming a very popular

tourist destination, SAARC region’s performance in this sector was rather poor.

At the moment, SAARC Member States are emphasizing attracting tourists from

other regions, especially from developed countries. But development of intra-

regional tourism could relatively be more prospective as compared to present

move. Tourism can help establish people to people contact that eventually will

help in building trust among the citizens of the region. The outcomes will be that

the investors in the region will find the prospective sectors such as infrastructure,

hotels, motels, transport, theme parks, etc. Not only that through the mobility of

people, many other potential sectors such as agriculture, industry, etc, could be

identified for investment.

3. Textile and Garments: This sector is also considered as an important sector in

terms of earning foreign currencies and job creation in the region. For example,

garments sector is the top ranking export sector for Bangladesh. If there could

have intra-regional FDI in this sector, some backward (forward) linkages are

possible. For instance, Pakistan is good in textile and Bangladesh is good in

garments. If there could have joint ventures between these two countries, these

would add value, enhance productivity, save foreign currencies, and also reduce

the cost of production that will in competing in the world market.

5. The Attitudes of Nationals towards FDI

The present attitudes towards FDI are due to massive changes in global economy, politics,

information technologies, and most importantly the mentality of all – the host countries,

the home countries and the MNEs (as MNEs are treated as the main driving force of

globalization). Dunning (1994) provides the changing world of FDI as follows:

13

Figure –1. The changing world of FDI

• From a country’s perspective

Renaissance of the market system.

Globalization of economic activity.

Enhanced mobility of wealth-creating assets.

Increasing number of countries approaching the “take-off” stage in

development.

Convergence of economic structures among developed countries

and some newly industrialized economies.

Changing criteria by which Governments evaluate FDI.

Better appreciation by Governments of the costs and benefits of

FDI.

• From a firm’s perspective

Increasing need to exploit global markets (e.g. to cover escalating

research and development costs).

Competitive pressures to procure inputs (raw materials,

components etc.) form the cheapest possible sources.

Regional integration has prompted more efficiency-seeking

investment.

Growing ease of trans-broader communications and reduced

transport costs.

Heightened oligopolistic competition among leading firms.

Opening up new territorial opportunities for FDI.

Need to tap into foreign sources of technology and organizational

capabilities and exploit economies of agglomeration.

Changes in significance of particular locational costs and benefits.

Need to better balances the advantages of globalization with those

of localization.

Source: Dunning, 1994.

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Historically, FDI flows were dominated by USA to its European allies dating roughly

from the Korean War (1950-1953) to the first oil shock (1973-1974). The Americans

have shown a greater preference for FDI and direct control than have other investing

countries, particularly Britain, France and the oil-rich nations, all of whom have

channeled a greater proportion of their foreign investments into portfolio lending.

Initially, in 1960s US firms introduced new and sophisticated products into the European

markets with FDI that became a matter of concern for Europe. It is documented from

Vernon (1971) where he showed in “Sovereignty at Bay” that the problems posed by the

so-called “American Challenge” were not strictly US oriented rather the US MNEs’

penetration to France with FDI. At the same time it was thought that such penetration

would influence the setting of national objectives by lowering the freedom in setting

national policies by those MNEs for their own interests. Whereas in 1970s and 1980s FDI

moved away from the Third World, where it had met resistance and expropriations

climaxing in the 1970s. Smeets (1998) states that FDI flows remained mainly

concentrated in the industrialized world, which could partly be explained by the existence

of large consumer markets and partly by the liberalization of capital markets, mainly

within OECD. Indeed, about three quarters of FDI inward stock and 60 percent of FDI

inflows were taking place in developed countries that were also the principal home

countries and invested 85 percent of world FDI. The triad (the EC, Japan, and US)

accounted for 70 percent of world inflows. The five major home countries (France,

Germany, Japan, United States and United Kingdom) accounted for two thirds of FDI

outward in 1980s.

This trend reversed itself beginning in 1992 as FDI flows into developing countries

increased dramatically as Dunning (1994) termed it as “good news” for FDI.

Qualitatively, developing countries (LDCs) enjoyed a wide variety of location-specific

advantages over and above natural resources (World Investment Report, 1997). At the

initial stage of development of FDI, developing countries were also less interested in

inviting FDI though TNCs due to their previous experience about TNCs where they

entered for trading and eventually intervened politics and captured political power (e.g.

15

East India Company in India). On the other hand, TNCs also complained against LDCs in

terms of different barriers put by the LDCs for the TNCs. The following figure shows the

complaints of both – LDCs and TNCs – against each other.

Figure – 2: Shows the complaints of LDCs and TNCs / MNEs

Complaints of LDCs against multinational

• TNCs extract excessive profits because of their oligopolistic or monopolistic market

position

• TNCs allocate markets to specific subsidiaries, thus not allowing individual

manufacturing subsidiaries to develop export markets.

• TNCs do not engage in research and development in all of the countries in which they

operate, thus causing technological progress in those nations to stagnate or even

regress in relative terms.

• TNCs set transfer prices for intermediate inputs at rates other than arms-length in

order to minimize tax consequences or discourage to entry of competitive firms that

would buy intermediate inputs.

• TNCs do not transfer ‘appropriate technology’ when establishing manufacturing

facilities, thereby minimizing the benefits of foreign capital and technology.

Complaints of TNCs against LDCs

• Setting high tax rates on the profits of multinational firms.

• Requiring the local production of many products, there by stimulating the local

economy by shifting employment into the host country.

• Encouraging the dissemination of technology by requiring that host country national

be employed at specific position within the foreign corporations.

• Restricting the ability of MNCs to protect proprietary technology through patent and

trademark law .

Source: Miller and Crespy (1993)

However, there are some intra-regional adverse attitudes among the people of the region

towards FDI. Although almost all the countries of the region are trying to attract FDI

16

from other regions, efforts are not so worthy for the same from each other. The main

reasons include lack of people-to-people contact, lack of mutual trust and confidence,

lack of political cooperation, religious hostility among nations, big brother type attitude

of India, lack of organized campaign about the benefits of intra-regional investments

among the people, etc.

6. Present and Potential Threats to FDI

It has already been established through earlier discussion that there are various

potentialities of intra-regional foreign direct investment. In spite of this prospect,

investment from the countries is not yet satisfactory. Because some hindrances prevailing

in the region that are acting as bottlenecks to the smooth flow of investment. Some of the

constraints for intra-regional FDI in South Asia are highlighted below:

a. Different Sizes of Economies: The enormous differences in size among the

economies in the region, above all, the overwhelming size of the Indian economy in

comparison to other countries in the region has proved to be psychological barrier for

other countries. As a big economy, India is in better position than other. Here India is

reluctant to open its economy for its neighbors, and the same attitudes are also prevailing

in other states.

b. Varying Economic Policies: The intra-regional investment flow is further hampered

because of differences in economic policies of the states. Various economic reform

programs have been adopted by the states without considering the regional cooperation

and coordination on economic policies among themselves. The safeguard measures

designed and adopted by some of these countries particularly to protect their respective

domestic industries indicate their conservativeness to welcome regional investment.

c. Trade Barriers: South Asian intraregional investment are also affected by the

presence of many trade barriers including tariff and non-tariff barriers, such as different

standardization and certification processes, subsidies on agricultural products and

different custom rules and regulations formulated in different states. The differences in

17

tax laws and regulations, exchange rates, interest rates, duty structure as well as

macroeconomic policies in general have proved to be a major factor inhibiting intra-

regional investment flows.

d. Poor Physical and Non-Physical Infrastructure Facilities: One of the important

preconditions for attracting FDI in a country is the presence of developed infrastructure.

Excepting India, other countries of the region still could not develop their infrastructural

facilities up to the mark. A study conducted by the Bangladesh Enterprise Institute in

2002, which was supported by the World bank, found that poor infrastructure, electricity

problems, corruption, excessive regulations and poor access to finance for Small and

Medium Enterprises (SMEs) were important factors that impede economic growth and

development of Bangladesh; that the investment climate was also a major factor in

influencing FDI flows into the country. The very same problem, in varying degrees, was

adversely impacting on the investment climate of all the other countries in South Asia

(Sobhan, 2004). The relatively poor regulatory, fiscal, and legal systems have held back

investment in South Asia by raising direct cost and by corruption; bureaucratic delays;

property disputes also create a sense of uncertainty.

e. Absence of Effective Banking Network: Presence of develop banking network

among the countries is another essential factor in any international business. The banking

network in the region is poorly developed; the level of cooperation between the central

banks of the states is all but absent.

f. Lack of Cross-Border Facilities: Another impediment has been identified for

insignificant intra-regional investment is the lack of sufficient cross border facilities like

transportation, and communication, etc. For smoothening production and marketing of

goods and services in the region, intercountry roads, rail, waterways, and airways modes

of transportation must be available at the required level. But still it is yet to have an

integrated transport network for helping the easy movements people and products.

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g. Political Factors and Acute Mistrust among the Nations: Majority of the countries

in the region were under British rule for about 250 years. After getting independence in

1947, India, and Pakistan became separate states. But these two countries could not build

trust on each other from the very inception. Subsequently Bangladesh got independence

in 1971 from Pakistan through a tragic war. Political hostility between Pakistan and India

has long been continued as they have many unsettled political issues like Kashmir.

Bangladesh also cannot trust Pakistan still for its earlier bitter experience. According to

the authors, this factor can be treated as the main impediment for poor level of intra-

regional investment. Thus political factors, acute mistrust and lack of confidence,

governance issues, lack of knowledge about each other’s financial system and capital

markets and the reluctance to share information are important factors regarding the

progress and pace of regional cooperation in South Asia.

With the above-mentioned constraints, we can cite about other impediments to South

Asian regional investment identified in SAARC Summit (Sobhan, 2004).

i. Low growth rates of the countries;

ii. Shallow credit market;

iii. Financial market imperfections and weak creditor’s rights that weaken the efficiency

of the credit market and restrict financing for investment;

iv. Low levels of private savings and financial development and high investment;

v. Identical comparative advantages;

vi. Low levels of FDI that reduce investment by limiting access to an important source of

finance and by forgoing the complementarity between foreign and domestic investment.

7. Some Remedial Suggestions

It is said that if there would have effective SAARC, this could be the largest trade block

in the World in terms of population. In order to create conducive conditions for

promoting intra-regional trade and investment the following measures should be

considered:

a. Building Mutual Trust and Confidence among Nations: This should be

considered as the main measure for effectiveness of SAARC. An

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organized political campaign should be taken to convey the message to the

people about the benefits of regional cooperation. In this regard,

politicians must be active in building trust and confidence among the

people of the respective nations. Increase in cultural exchanges,

development in tourism sector, reduction of bureaucracy in the mobility of

citizens, not letting territories for using by the terrorists, etc. can be some

measures for boostinf up the trust and confidence.

b. Harmonization: This includes fiscal policies, investment policies;

exchange rates, tax laws, custom laws and procedures, national standards

and certification process, common investment strategy towards FDI,

uniform liberalized rules and regulations for FDI should be formulated.

This can be materialized through South Asian Preferential Trade Area

(SAPTA)

c. Creating an Investment Area: A SAARC investment area, similar to

ASEAN investment area, can be established in generating intra-regional

investment flows as well as attracting FDI from outside the region.

d. Building Networks Among Financial Institutions: An integrated

network can be set up among the banks (including central banks) and other

financial institutions to ensure free flow of information and funds. A

SAARC Investment Authority can be built up to facilitate investment,

improving bank links, intensify cooperation among the stock exchanges in

the region.

e. Physical Infrastructure Development: An effective initiative should be

taken by the states to develop intra and inter country infrastructural

facilities that include rail, ports, roads, air transports, electricity,

telecommunication, etc. These will enhance flow of goods and services

within the region.

f. Establishment of Free Trade Area: At present there is a regional

agreement among the states known as SAPTA that concentrates only on

trade and commerce, a move should be taken to form a South Asian Free

Trade Area (SAFTA) for speeding up investment cooperation in the region.

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g. Encouraging Sub-Regional Cooperation: Intra-regional investment can

be increased if countries of the region can exploit opportunities for sub-

regional cooperation that are based on geographic proximities and

common economic interests.

h. Cooperation in Government Level: Governments of the region should

be more proactive by taking measures relating to regional cooperation in

general and SAARC in particular. Institutional supports should be strong

for close interaction and cooperation among governments, ministries,

government agencies, public and private sectors, etc.

i. Cooperation in Non-Government Level: South Asian cooperation can

be enriched through establishing interaction among the non-government

organizations like Chamber of Commerce, Trade Associations,

Educational and Cultural Institutions, Religious Groups, Social

Institutions, Professional Groups, etc.

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Appendix-1: Size of Economies in SAARC Member Countries Gross nationalIncome

Gross national income per capita

PPP gross national income Gross domestic product Country Population2001

Surface area Thousand of sq.km 2001

Population Density People per sq.km2001

$ billions 2001

Rank 2001

$ 2001

Rank 2001

$ billions 2001

per capita $

Rank 2001

% growth2000-01

Per capita % growth 2000-01

Bangladesh 133 144 1,024 48.6 51 360 172 213 1,600 173 5.3 3.5India 1,032 3,287 347 477.4 12 460 162 2,913 2,820 143 5.4 3.7Nepal 24 147 165 5.8 108 250 190 32 1,360 180 4.8 2.4Pakistan 141 796 183 60.0 44 420 164 263 1,860 167 2.7 0.3Sri Lanka 19 66 290 16.4 73 880 140 61 3,260 134 -1.4 -2.8

Source: World Development Indicators, 2003, The World Bank, Washington DC, USA.

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